This year’s decline in digital assets has been gut-wrenching for those investors who bought in at the top. Even crypto diehards, while still convinced that the world is on the brink of a blockchain-powered revolution in finance, were shaken by the market rout. For those who still keep the faith, the “crypto winter” will be like the dotcom bust of the early 2000s – weeding out failed enterprises to make way for more promising startups. Others wondered when spring would come. The November collapse of one of the industry’s largest exchanges, FTX.com, underscored the risks of assuming the worst was over.
Why a new ‘Crypto Winter’ is the test for digital money
1. What is a crypto winter?
It is similar to a bear market for other assets. Stocks are in a bear market when a benchmark falls by at least 20% from its previous peak. Crypto winters usually feature dramatic drops followed by long bouts of weak prices and thin trading volumes. A recession that began in 2018 wiped out as much as 88% of the market value of all crypto assets, according to tracker CoinMarketCap. Between a peak in November 2021 and a low in mid-June, they fell as much as 71%, wiping out an estimated $2 trillion in market capitalization, according to rival tracker CoinGecko.
2. What causes crypto winters?
In their short lifespan, crypto markets have become synonymous with exuberant booms and panic-induced busts. Bitcoin lost around two-thirds of its value in 2014, driven in part by the failure of a major crypto exchange. The decline in 2018 came amid a regulatory crackdown on so-called initial coin offerings that led to the demise of thousands of newer cryptocurrencies.
3. How did this happen?
This time, forces outside the crypto world played a role. As central banks loosened monetary policy in response to the coronavirus pandemic, investors piled into blockchain startups and digital assets. Later, as central banks began to reverse course, cryptoassets plummeted — exploding the idea that they had a similar status to gold as a refuge for investors in times of economic uncertainty. The decline triggered the collapse of the TerraUSD stablecoin (a digital token designed to maintain a link to the US dollar). This in turn led to the failure of, among others, the hedge fund Three Arrows Capital, the crypto broker Voyager Digital and the crypto lender Celsius Network. Prices fell further in the following weeks as investors wondered how far the contagion could spread.
4. Why was it so brutal?
Even by the industry’s own volatile standards, it was a spectacular route. Crypto should have come of age since the days when it was the obsession of a core of “true believers” and shunned by most investors. The implosion of TerraUSD, Celsius and others was a shock to the managers of pension and sovereign wealth funds – and millions of small investors – who embraced crypto in recent years, as well as to venture capitalists who had driven tens of billions of dollars. into crypto startups at astronomical valuations. It turns out that the bull market of recent years was built on shaky foundations because many investors borrowed heavily to bet on digital coins and projects, often using other crypto as collateral.
5. What was the fallout?
The damage done to both institutional and small investors has put governments under more pressure to drag crypto into the same path as traditional finance, with enhanced regulatory oversight to avoid more disasters. Critics see the decline as evidence that cryptoassets are still too risky to have a place in conventional investment portfolios. Even crypto cheerleader Elon Musk took a step back: His electric car company Tesla Inc. sold 75% of its Bitcoin holdings. Many crypto companies laid off employees, including exchanges Gemini Trust and Coinbase Global Inc. and non-fungible token marketplace OpenSea. Investors were wary of diving in too soon, fearing that problems in one part of the industry could spread quickly and in unexpected ways, leading to heavy losses elsewhere. The risk was underlined in November, when an increase in customer withdrawals led to a liquidity crisis at FTX, the exchange founded by star crypto entrepreneur Sam Bankman-Fried.
6. What are the prospects?
The winter of 2022 gave ammunition to critics who see crypto as a purely speculative investment. It showed that crypto is not – as proponents often claim – decoupled from the fortunes of traditional financial assets, and can be just as vulnerable to rising interest rates as other investments such as technology stocks. Almost a year after winter began, prices and trading volumes were still weak, and some crypto startups with workable business plans ran out of money. Many of the crypto miners who play a vital role in ordering transactions on blockchains – the digital ledgers that underpin crypto – were in dire straits as the value of the tokens they earned had fallen and rising energy prices had inflated their utility bills.
Crypto has a history of comebacks, and some big institutional investors weren’t deterred by the rout: In August, BlackRock Inc. announced its first-ever fund to enable direct investment in Bitcoin. That same month, hedge fund firm Brevan Howard raised more than $1 billion for a crypto fund. Just as the last downturn led to the emergence of fewer, stronger businesses, businesses that survive the current winter will have fewer competitors and more room to mature and improve their offerings. The increasing regulation, while increasing the uncertainty surrounding crypto in the short term, could ultimately make it a more respectable, stable asset class.
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